ForeclosuresMass - ForeclosuresMass Monthly - Interview with the Expert - Incorporate Real Estate Into Your Financial Plan (March 2007)

Successful real estate investors will tell you that having a financial plan is a key component of their success. We recently spoke with Judy Carryl-Young, a licensed, for-fee financial advisor about the importance of financial planning and the questions you should ask yourself when considering real estate investments.

ForeclosuresMass Monthly: Judy, thank you for taking time to talk with our audience. Why do real estate investors need a financial plan?

Carryl-Young: That is a great question. I have clients who come in and say, "I want to invest in real estate!" They've heard that real estate will generate the income they need. They get excited and want to put all their money into it.

What they forget - or maybe don't understand - is that as an investor, you have to perform the same due diligence and planning as you would (or should) with any investment. Clients who want to put everything they have into real estate forget about asset allocation, risk, and protecting their assets. For them, real estate becomes a single asset investment.

* Next 37 17 investors only!

C-Y: When you put your money into one basket, you significantly increase your risk - as Enron employees and stockholders learned when Enron went under. Or, during the 1990s stock boom, people put all their money into high-tech stocks and lost everything when the market crashed.

I'm not saying that investing in real estate is risky. I'm saying that if you put your entire life savings into it, you're stepping into very risky territory. Of course, a few people do make it work. But for your average investor, it's not a scenario any financial planner recommends.

FMM: What are some of the questions financial planners ask when helping clients evaluate real estate investing?

C-Y: The first question I ask is, "Have you invested in anything before?" It's the same question I ask of people who state they want to begin investing in the stock market. A financial planner needs to determine a person's investing experience. If someone has little or none, real estate may not be the best first choice.

The second question concerns risk tolerance. For people who are risk adverse, I do not recommend buying foreclosed properties or properties at auction. The risk could overwhelm them. A REIT (real estate investment trust) might be a more comfortable way for them to invest in real estate.

I then talk to potential investors about what they know about real estate. I try to help them understand they have the potential for becoming a landlord (some people don't want this responsibility), and that they need to learn how to make a venture profitable enough to make it worth the time and expense.

The time thing is something most people don't consider. Do you have the time to rehab a property? If you're not doing it yourself, do you have the time to oversee a contractor who will? I ask my self-employed clients, "Can your business withstand the time you'll be spending away from it managing your property?"

Finally, I ask a series of questions concerning the person's finances: the number of assets held, cash reserve levels, and committed versus discretionary expenses. (Committed expenses mean payments you have to make, such as your mortgage. Discretionary expenses refer to those you can lower or eliminate, such as your cable bill). Ideally, a potential investor should have 3 - 6 months of cash reserves.

C-Y: Yes, everyone should have 3 - 6 months (or more) saved. But it's very important for potential real estate investors to have the ability to cover an additional 3 - 6 months of committed expenses when investing in a property.

Let's face it - real estate is sexy and enticing. Everything you hear is about making money. What you don't hear, however, is about the hard work, the deadlines, and the cost overruns. I ask people, "Are you prepared to carry two mortgages if you're not able to flip the house in your planned time frame? Are you prepared to have the house sit empty for a few months if you can't rent it out?" If they're counting on that income, and they can't flip or rent the house, they need to be able to cover those contingencies.

FMM: It sounds like you're trying to help people understand that real estate should be part of a well-diversified investment portfolio.

C-Y: Yes. Exactly. I want people to do due diligence and not see real estate investing as a "quick fix" or an easy way to make money.

FMM: Judy, which questions should people ask when considering a financial planner?

C-Y: First, know the difference between for-fee and commission-based financial advisors. A for-fee advisor will charge you upfront to help you develop a financial plan. Commission-based financial planners may not charge you for financial consulting or advice because they get paid based on commissions on the products they recommend you purchase (i.e. annuities, mutual funds, full-term life insurance, etc.).

Some financial planners, like myself, are both. I do financial advising - and charge a fee for it. I may also recommend financial products, for which I receive commission, but you are not required to purchase them.

If the advisor is part of a large organization, you can call and verify credentials. For example, I'm part of the Ameriprise Financial Services, Inc. network. You can call Ameriprise Financial and verify everything about me.

Bottom line: You'll be sharing your most intimate financial details with an advisor, so you want to ensure the relationship is based on trust and sound business practices. If a prospective advisor is not forthcoming with information, or something seems "funny" or "off," or if you're pressured to purchase financial products, cross this person off your list.

C-Y: As I said, real estate is just like any other investment. Determine how it will fit into your short- and long-range financial plans and your lifestyle, remember that it should be part of a well-diversified portfolio, and don't put all your eggs into one basket. If you do your homework, you'll be successful.

Judy Carryl-Young, JD, L.L.M, CRPC(r) runs an independent financial practice, located in North Andover, MA, and is a franchise of Ameriprise Financial Services, Inc. She can be reached by phone at 978-662-0494 or through her website at http://ameripriseadvisors.com/judy.a.carryl-young.